Ten Year Sensex PE

Apr 27, 2017

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The BSE Sensex and NSE Nifty are at all-time highs. The BSE Sensex closed comfortably above the magic figure of 30,000 for the first time. The midcap and small-cap indices are trading at insane valuations.

In euphoric times like these, investors find reasons to buy stocks - growth stories, stock re-ratings, margin expansion, new opportunities, etc.

I had an interesting conversation with my friend last week. His rationale was simple: 'Midcap and small-cap indices are trading at PEs of around 32 and 70 times. Very expensive. But look at the BSE Sensex and NSE Nifty. Trading at 22 times. This means plenty of opportunities in the large-cap space.'

That's how investors justify valuations. They say the current PE is still less than in 2007-8. During the January 2008 peak, the Sensex PE was around 28 times. They further say this is just the start of the bull market and, top-down, the market looks attractive.

Here's what Tanushree wrote about valuations and returns:

The current valuation of the index - more than 22x - is rare. Over the past two decades, the NSE Nifty has traded above 22x only nine times. And when it does, buying even the biggest blue chips has come with a huge downside for long-term investors. On five out of the nine occasions, the index lost money over a two-year period. So the historical data suggests there is currently a 60% chance of losing money in bluechip stocks.

Here's another interesting observation.

The market may look reasonable from a top-down approach. But individual stocks look either fairly valued or expensive from a bottom-up perspective.

Why?

Remember, the index comprises several sectors. Some sectors pull down the overall valuations.

How?

Consider the commodity, energy, IT, and PSU bank sectors. These sectors trade less than the index valuations and contribute more than half of the total profits of the index.

In other words, the high weights of low-PE stocks or sectors camouflages the expensive stocks. Looking at the markets top-down - that is, looking at the broader indices - valuations look reasonable.

But it's better to forget the indices and use a bottom-up (a stock-specific) approach.

This is the StockSelect team's approach. They focus on the underlying business. Its earning power, the business model, growth opportunities, and valuations.

As per the latest December 2016 audit, StockSelect has a success rate of 79.9%. So with this approach, that's four winners for every five recommendations for the last fifteen years.

According to Tanushree, 'You can't buy the best blue chips by following index trends. Rather, you need to take a contrarian view on the best blue-chip businesses.'

Learn more about that here.

This Chart Of The Day was published in The 5 Minute WrapUp - Sensex PE May Look Cheap... But It's Not

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